How to play hot silver market and not get burned

Volatile metal poses challenge but offers potential for more gains

Silver has swung in 2012 between a low of $28.68 to a high of $37.14, after ending last year with a decline of 9.8%, even as gold rallied 10%.

SAN FRANCISCO (MarketWatch) — Silver prices are outpacing gold this year, prompting cautious investors to wonder how to play the market while guarding against the white metal’s well-worn path of volatility.

Silver futures
SIK2
are up 20% year to date, closing at $33.83 an ounce on Thursday at the New York Mercantile Exchange. By contrast, gold futures
GCJ2
have risen 8.4% and are trading just below $1,700 an ounce.

“After a period of doodling around the $30 mark after the April 2011 crash, silver has perked up and outrun gold, largely because of fear in the smaller-investor base that makes up the bulk of silver investing interest,” said Christopher Ecclestone, a mining strategist at Hallgarten & Co. LLC.” This is a very nervy crowd and relatively under-resourced, so this makes silver more vulnerable to wild swings in popular sentiment.”

Indeed, silver has swung this year alone between a low of $28.68 to a high of $37.14 on a closing basis, after ending last year with a decline of 9.8%, even as gold rallied 10%.

‘Investors who have the discipline to play the cycles within the greater metals bull trend can make a lot of money by using silver’s leverage to gold.’
Brien Lundin, Silver Bullet Strategy Report

“Silver has historically moved much more quickly than gold, both to the upside and to the downside,” said Brien Lundin, author of the Silver Bullet Strategy report, published by Gold Newsletter. “As a result, investors who have the discipline to play the cycles within the greater metals bull trend can make a lot of money by using silver’s leverage to gold.”

Besides, “considering that silver was threatening to hit $50 a little less than a year ago, and considering that it could quickly do so again on any major rally, I think the current levels are indeed a bargain,” said Lundin.

Prices have fallen by around 9% from their settlement above $37 on Feb. 28.

All of that makes silver attractive, despite its penchant for volatility.

Weighing risks

Many fundamentals lately help explain just how volatile prices have been in 2012.

“Everything that supports gold also supports silver,” said Lundin. “And that list would include the massive amount of monetary liquidity that has been created since 2008, and the huge debts that have been amassed in the Western world over the past decades.”

Other supportive factors include rising demand for the metal’s multitude of uses.

“Industrial demand for silver has moved from wants to needs, so [silver is] less vulnerable to economic downturns,” said Julian Phillips, an editor at SilverForecaster.com and GoldForecaster.com, suggesting that photography and jewelry uses are among the “wants,” while solar panels, medical and electronic uses are among the “needs.”

The world’s apparent usage of copper grew by 2.7% in the first 11 months of 2011, versus the corresponding period a year earlier, according to preliminary data from the International Copper Study Group. The October-November period world consumption was up 12% on the back of a 38% increase in China, the world’s second-biggest consumer.

Even so, the slowing pace of global economic growth has been a concern, highlighted by China’s move last week to scale back its own growth target. Read more on China.

“A Chinese slowdown will be bearish for both gold and silver as they are [among] the biggest gobblers,” said Chintan Karnani, chief analyst at Insignia Consultants in New Delhi.

Other possible risks to silver futures include a global recession, central banks raising interest rates, and the debt crisis in the euro zone, Karnani said.

But Lundin said it won’t be the industrial component of silver demand that will mainly drive its price higher. It is investment demand that drives the silver market — and that demand is “driven, like gold, by monetary inflation. The more money that gets printed, the higher gold and silver prices will be.”

‘Industrial demand for silver has moved from wants to needs, so [silver is] less vulnerable to economic downturns.’
Julian Phillips, SilverForecaster.com

Demand for silver as an investment is on the rise, particularly as gold prices “move out of the reach of the lower middle- to working-class investors in the emerging world,” according to Phillips. The iShares Silver Trust
SLV, +1.23%
backed by silver bullion, has climbed more than 20% year to date.

But interest in the white metal can sway either way. Mark Leibovit, chief market strategist at VRTrader.com, attributed some volatility to market manipulation, which he also calls “financial terrorism.” The recent gold and silver “flash crash” was “clearly an abnormal move,” he said.

“As investors or traders, we’re at the mercy of larger players who sometimes work in our favor,” said Leibovit. But “even the smackdown last week … by those attempting to manipulate the market is par for the course.”

Tempering risk

With such a complicated set of factors driving its prices, analysts suggest a few ways for investors and traders to temper risk.

Karnani suggested that Comex silver futures comprise 20% of an investor’s silver investment, and that he prefers to invest in them at around $31, with a price target of $42-$51, if the investment plan is long term. Other analysts, however, see the futures market as too risky.

Lundin said an investment strategy may also include Comex silver options. Buyers of call options pay a premium for the right but not the obligation to be long the underlying market at a specific price for a specific period, he says. Call options buyers aren't buying the market. They are merely buying the right to be long that market.

Karnani suggested that silver coins represent 50% of total silver investment, based a “systematic” investment plan. An investor who puts $500 a month into silver investing “should give a return of more than 15% in 2012.”

Purchasing 90% silver U.S. coins, known as “bag silver,” may be the best way to invest in physical silver, said Lundin, adding that the bags are typically traded in increments of $1,000 in face value. They come in various coin denominations, though some dealers sell $500, $250, or even $100 face value bags, possibly at a higher premium.

For the remaining 30% of Karnani’s suggested strategy, he proposed exchange-traded funds, with an investment time period of three to five years. “ETF returns always lag behind physical prices,” he said.

Edmond Bugos, director of mining finance at Strategic Metals Research & Capital, prefers ETFs and likes the Central Fund of Canada
CEF, +0.68%
which owns both gold and silver, as well as the Sprott Physical Silver Trust
PSLV, +1.07%

He still prefers gold overall, though has enough exposure to silver through CEF, he said.

Building a portfolio of companies that explore for or produce silver can deliver substantial leverage on rising silver prices too, according to Lundin.

Great Panther Silver Ltd.
GPL, +0.00%
(GPR) and Silvercorp Metals Inc.
SVM, +2.69%
(SVM) have profitable and growing silver production, and South American Silver Corp. (SAC) “has a large silver resource that is currently undervalued by the market ...” said Lundin, who has no positions in any of those stocks.

Best guess

One thing is certain when it comes to silver this year: expect to be just as volatile as ever, analysts said.

“I wouldn’t dare say that the days of sub-$30 are over. Considering how volatile the metal is ... silver could correct below $30 the moment after I claim it never will,” Lundin said. But the trend is “definitely upward and it appears much more likely that silver will trade over $40 before it trades under $30 once again,” he said.

Jeffrey Wright, senior research analyst with Global Hunter Securities, said he envisions a scenario where a significant drop in industrial demand on a global scale leads to a decline in the price of silver below $30, as was the case in the fourth quarter of last year. That is when prices dropped around $8.

But SilverForecaster.com’s Phillips believes that the days of sub-$30 silver prices are over, as demand outpaces production. “Just as the oil price is moving up on growing global demand, ensuring we have probably seen the last of $80 [a barrel] … so silver has risen to a new minimum plateau.”

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